FHA Loans and Requirements

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What is an FHA loan?

An FHA Loan is a mortgage that is backed or insured by the Federal Housing Administration that is available to home buyers with down payments as low as 3.5% or a low credit score. FHA loans are a form of federal assistance that allows all Americans the opportunity to become homeowners. Different types of homes such as single-family homes and multi-family homes are eligible to be insured by the FHA.

FHA Loan Requirements

There are certain requirements to qualify for an FHA home loan such as:

A credit score of 500 or above

A credit score of 580 and above will allow for a minimum down payment of 3.5%.

A credit score between 500 and 579 will require a minimum down payment of 10%

FHA loans are one of the few mortgage loans that allow for such low credit scores making them the only alternative available for some borrowers. It is also important to note that with a lower credit score, there will be less negotiating power when the interest rate is being determined by the lender of the FHA-insured loan. FHA loan is one of the most popular ways to buy a house with bad credit.

* * A credit score is a number between 300–850 that depicts a borrower's creditworthiness. A higher score signifies a better ability to repay lenders and debtors in a timely manner. A credit score is based on several factors such as the number of open accounts, total levels of debt, and repayment history, etc. The most common credit score in the US is the FICO credit score.

MIP (Mortgage Insurance Premium) is required

MIP (Mortgage Insurance Premium) is charged by FHA in exchange for protecting the lender in the case of default by borrower. The FHA MIP is divided into an upfront fee of 1.75% of the loan amount and an annual fee of 0.45% to 1.05%. FHA MIP, in contrast to PMI, is NOT impacted by your credit score, it depends on total value of the loan, loan to value ratio and term of the loan. Therefore, even if you have a lower credit score you will not pay a higher MIP rate. Use the FHA MIP Calculator to estimate your FHA mortgage insurance premium.

A downside of FHAs is that if you put less than 10% down payment, you will have to pay mortgage insurance premiums for the entire life of the loan. Meanwhile, if you put at least 10% down, you will only have to pay mortgage insurance premiums for 11 years of the loan.

Debt-to-Income Ratio < 43%

To qualify for an FHA loan you must have a debt-to-income (DTI) ratio of less than 43%, that is your total monthly debt cannot be greater than 43% of your monthly pre-tax income.

The Debt-to-Income (DTI) Ratio is the ratio that measures the monthly debt payments including principal & interest payments such as a mortgage, student loans, credit cards, and other debt to your income. The monthly debt payment as defined by Fannie Mae, is the sum of the monthly payments for auto loans, student loans, and mortgages, plus the minimum required monthly payment for credit cards. For example, if your monthly debt payment is $1,500 and your monthly pre-tax income is $4,000 then your debt-to-income ratio is 37.5% ($1,500/$4,000).

The home must be the borrower‘s primary residence

The FHA loan must be used as the primary residence by the home buyer. If the house is not the primary residence, the FHA loan will not be approved. This is to ensure that FHA loans can go to low-income families to buy their house and not be used for investment purposes.

The borrower must have a steady income and proof of employment

The borrower must show proof of employment as in most cases income from employment is the primary source to pay back the monthly mortgage. You must also have two established credit accounts such as a credit card, car loan or student loan.

FHA Adjustable-Rate Mortgages (ARM)

An adjustable-rate mortgage (ARM) has an interest rate that changes periodically over time, usually once a year. ARM mortgages follow a benchmark index like the Prime rate along with a credit spread to determine the monthly rate. Most ARM loans taken today are‘hybrid loans’ that start off with a fixed interest rate for a definite period of time, after which it will begin to adjust each year.

Annual and lifetime rate caps: The FHA limits how much your interest rate can adjust each year and over the lifetime of the loan. These adjustment caps are there to protect borrowers from overwhelming spikes in their monthly payments.

• 1- and 3-year ARMs: 1% increase annually, up to 5% increase over the life of the loan
• 5-year ARMs: up to 2% increase annually, up to 6% increase over the life of the loan
• 7- and 10-year ARMs: 2% increase annually, up to 6% increase over the life of the loan

Types of FHA Loans

1. Basic Home Mortgage Loan 203 (b)

   The basic home mortgage loan 203(b) is the most popular type of FHA loan and it is the one we have been referring to up to now. With an FHA 203(b), you are eligible to put a down payment of as low as 3.5% if you have a credit score equal to or higher than 580. This FHA loan is offered with either a fixed or adjustable interest rate. You can use a FHA 203(b) loan to purchase different types of properties such as single-family homes, 2-to-4 unit multifamily owner-occupied homes, condominiums, townhouses, or manufactured homes. It is important to note that FHA only insures the loan, while FHA-approved lenders are the ones who give you the loan.

2. FHA Streamline

   With an FHA streamline, a borrower can refinance its current FHA loan and take advantage of some of the perks the refinance offers. An FHA streamline allows more flexibility in terms of refinancing as the appraisal process does not need to be conducted again. If you choose to get an FHA streamline, minimal paperwork will be required since documentation on employment, income and assets has already been collected from you once. Another benefit of this option is that the borrower will probably be offered lower rates on mortgage insurance premiums, both upfront and annually. Moreover, a refinance is also available in the cases where the borrower owes more than the home is worth.

3. FHA Rate/Term Refinance

   This is an option available to borrowers who already have a mortgage and whose creditworthiness has declined, but want to refinance their mortgage to take advantage of lower interest rates. Since FHA offers less strict credit requirements, the borrowers’ creditworthiness will not be an issue for as long as they have a score of at least 580. In the better case scenario that their credit score is at least 620, these borrowers can also be permitted to take on more debt through their refinance. However, depending on how much home equity they own, they might also be obligated to pay mortgage insurance premiums throughout the life of the loan.

4. Cash-out refinances

   FHA allows borrowers to pay off their existing mortgage and take on a larger loan. Some of the requirements are that the borrower must leave at least 20% equity in his home based on the new appraisal if he chooses the cash-out refinance option. Moreover, full documentation on employment verification, income and assets is required.

5. 203(k) Rehab Mortgage

   The FHA 203k loan is provided by the Federal Housing Administration to incentivize low- and moderate-income earners to purchase homes that are in need of repairs and maintenance. Using this loan, a borrower can renovate a property and earn sweat equity, which is the difference between the value of the property before and after renovation. FHA 203k loan is also known as an FHA Rehab Mortgage Insurance because the loan has two purposes, home purchase, and home renovation. The total amount that is borrowed not only includes the price of the home, but also the cost of renovation such as material and hired labor. The cost of the renovation and rehabilitation must be between $5,000 and $35,000.

6. HECM Reverse Mortgage

   Reverse mortgage loans insured by the FHA are called home equity conversion mortgages (HECMs). They allow senior homeowners to unlock their home equity and receive payments instead of making mortgage payments. HECMs have no minimum credit score requirement, unlike other FHA loans.

Check out our FHA construction loans and home improvement loans pages for more information.

What is Gift Money Regarding Mortgages?

It is money that is provided by friends and family for the use or purchase of a home. The most important requirement is that it can be proven that the money is sent by them. Gift money can also come from the government such as programs designed to help first-time low-income buyers such as the Homeownership Voucher Program.

As the FHA is a government agency it does have down payment assistance programs, for conventional loans, there is no formal program in place, it will depend on the lender. On the other hand, many states, counties and even single municipalities provide first time home buyer programs in their respective jurisdictions.

How Do I Apply for an FHA Loan?

FHA loans have a similar application process as conventional loans. FHA-approved lenders are determined by the Federal Housing Administration and these lenders provide the mortgage. There are 6 basic steps in the process:

1. Find an FHA Lender – There are several lenders that can offer FHA loans, however, it is important to do research and find the best lender for your needs. Some FHA lenders might not offer certain FHA loans such as the FHA203k loan which is used for repair and maintenance of the home. By finding several lenders, you can also try to get the lender that can give you the best mortgage rate.
2. FHA Application – In this application, basic financial information such as income, debt, and cash liquidity will be required.
3. Credit Score Verification – The lender will require permission to obtain your credit score to ensure you meet the minimum credit score requirements.
4. Detailed Financial Information – In this stage, you will be asked for detailed information regarding employment and income. This will include pay stubs for the past month, 2 years of federal tax returns, and employer contact information.
5. Down Payment Information – The funds for the down payment will be reviewed in order to ensure it is eligible. You will need to show at least 2 months of bank statements or provide a letter of explanation as to the sourcing of the funds for the down payment and closing costs. Gift money and down payment assistance programs can be used for the down payment. In some cases, if the debt-to-income ratio (DTI) or the loan-to-value ratio (LTV) is too high, lenders will check to see if there are enough funds for 2-3 months monthly mortgage payment. This is known as the mortgage reserves.

6. Miscellaneous Checks – In the last step, FHA lenders may ask for an explanation for any debt that has been defaulted in the past. Lenders have access to the Credit Alert Interactive Verification Reporting System (CAIVRS).

   There is another less popular way to obtain an FHA loan. If a seller has an outstanding FHA loan on the property they are selling, the buyer can take over their loan through a Transfer of Physical Assets (TPA).

FHA Loans vs. Conventional Loans

*The percentages show the market shares of each home financing option. Cash purchases of homes are responsible for 11% of the overall home financing. The diagram uses data from 2019.*

Conventional loan interest rates are typically a little higher than FHA mortgage rates. That’s because FHA loans are backed by the Federal Housing Administration, which makes them less risky for lenders and allows for lower rates. FHA loan is a great loan type for people who do not have enough to cover the down payment. Some people may choose easy but expensive ways to raise funds for the down payment simply because they are not aware of other options. For example, a homebuyer can withdraw money from 401(k) to buy a home and pay a lot of fees or get an FHA loan with a lower down payment requirement. Today’s average FHA rates are as low as 2.25%, while conventional rates are as low as 2.875%. However, if you have a great credit score (above 680, in most cases) you might qualify for a lower conventional rate. You also have to consider the annual mortgage insurance rate with each loan. Depending on your credit score and down payment, conventional mortgage insurance rates could be higher or lower than FHA insurance rates. This will affect which loan is cheaper overall.

Check out our Conventional vs FHA Loans page for more information.

The following table highlights the key differences between FHA loans and conventional loans.

There are advantages and disadvantages to both loans as shown in the table.

FHA Pros

1. The major advantage of FHA loans is that it is available to consumers with aminimum credit score of 500, whereas conventional loans require a minimum credit score of 620; otherwise the application is not considered
2. The next advantage of FHA loans is that the minimum down paymentis 3.5% if the credit score is 580 and above. However, if your credit score is even lower then you must be able to provide at least a 10% down payment.This allows low-income earners or first-time buyers the flexibility to purchase a house. Whereas, for conventional loans, the minimum down payment is 20%, unless you choose to buy insurance (PMI). Conventional loans also have introduced new loans such as Conventional 97 which require down payment as low as 3%.
3. In order to provide flexibility to home buyers the FHA allows for the entire down payment to be funded as a gift. For conventional loans, 100% of the down payment can come in the form of a gift as long as the home is the primary residence of the borrower and it is a 1-unit or single-family home.

FHA Cons

1. A disadvantage of FHA loans is that it requires all homebuyers to buy insurance or FHA MIP. The FHA mortgage insurance premium (MIP) is divided into an upfront cost and an annual premium.
2. Conventional loans only require insurance or private mortgage insurance (PMI) if the down payment is less than 20%. In both cases, mortgage insurance increases your mortgage APR and your total cost of borrowing.
3. PMI can be canceled if your Loan-to-Value (LTV) ratio falls below 78% or when the loan balance reaches 80% of the home’s original value.
4. The FHA MIP has an upfront expense of 1.75% of the total loan amount, with an annual fee ranging from 0.45% to 1.05%. Conventional loans have an annual fee of 0.5% to 2% of the loan amount.

FHA Loans vs. VA Loans

A VA loan, or Veterans Affairs (VA) home loan, is a mortgage where a portion of the loan is backed by the US Government through the Department of Veterans Affairs. In order to qualify, a Certificate of Eligibility (COE) is required. The borrower must be a service member or veteran or a spouse of a military service member/veteran. It is similar to the FHA loan because both of these home loans are guaranteed by the government and are provided by pre-approved financial lenders. VA loans also have an additional cost known as a VA funding fee which ranges from 0% to 3.6% in 2021. The fee changes depending on several factors such as the type of VA loan, amount of down payment, and the number of times you have used the VA program. Find the lowest mortgage rates on the VA loan rates page and in order to determine your monthly mortgage payment use the VA loan calculator which includes the VA funding fee.

VA loans have limits that are varied by county and price of the house; these limits can be found on the Department of Veterans Affairs's website. VA loans also have an additional cost known as a VA funding fee which ranges from 1.4% to 3.6% in 2020. The fee changes depending on several factors such as the type of VA loan, second time use of VA home loan and whether there's a down payment.

FHA Loan VS VA Loan

The minimum credit score for FHA loans is 500, which will require a minimum down payment of 10%. Although VA loans do not have a required minimum score, most VA backed institutions look for a credit score of at least 620. The average credit score of VA purchase borrowers in 2019 ranged from 706 to 713.

FHA loans require a down payment of 10% if the credit score is between 500 and 579; if the score is at least 580, the down payment can be as low as 3.5% of the purchase price. VA loans do not have minimum down payment requirements, however, there are certain restrictions such as:

1. If the appraised value of the home exceeds the market value of the home, the difference will have to be paid
2. If the home loan exceeds the VA county limit, then a down payment will be required

What is Market Value and Appraised Value?

The Market value of a property is determined by how much potential buyers are willing to pay in the current market environment. It is essentially the final purchase price negotiated between the buyer and the seller for the property. Market value can often be influenced by the buyer because the property is only worth what the buyer is willing to pay. For example, if the seller lists the price for $350,000 and the buyer places a bid for $325,000, the seller accepts the offer resulting in the final purchase price of $325,000 making that the market price.

Appraised value has less variance as compared to market value because the appraised value is determined by certified professionals such as an appraiser or lender. The appraisal process is not arbitrary such as the market value, as the appraiser takes several factors into consideration such as the property’s dimensions, utilities, surrounding neighborhood, value of similar construction houses, and schools, etc.

^† While we try our best to get your the best rates, we cannot guarantee that they are always accurate. Casaplorer® assumes no liability and provides no warranty for the accuracy of the information presented, and will not be held responsible for any damages resulting from its use. Rates shown are for informational purposes only and may differ by zipcode, county, and state. Estimated payments do not include taxes and insurance. Some state and county maximum loan amount restrictions may apply. Casaplorer® is not endorsed or sponsored by any mortgage lender or government agency. For information regarding any of these rates, please contact the relevant mortgage lender.